Ball Dropped On Carry

Carried interest, essentially performance fees, for private equity firms should be taxed as income rather than capital gains. But Blackstone boss Stephen Schwarzman and many of his friends unsurprisingly object, sometimes to hyperbolic extreme. And the additional revenue wouldn’t make much of a dent in the U.S. deficit. So despite the symbolic value, the idea is losing out to politics.

[The tentative Dec. 7 tax deal between President Barack Obama and congressional Republicans made no mention of raising taxes on private equity gains. Also, the U.S. Senate’s Finance Committee last week dropped that idea from a bill to extend broader tax cuts enacted in 2001 and 2003.]

The latest Senate plan to remove the carried interest loophole last week became a victim of the horse-trading around extension of Bush-era tax cuts that would otherwise expire at the end of the year – a negotiation that brought a tentative deal between President Barack Obama and congressional Republicans on Tuesday.

It’s understandable if lawmakers were focused on bigger-ticket items. Taxing carry isn’t going to solve America’s fiscal problems. A House measure passed a year ago was expected to raise something approaching $25 billion over a decade, or an average of $2.5 billion a year. The country’s deficit is running above $1 trillion annually.

Raising the tax rate on carried interest would, however, have been consistent with the recommendations of Obama’s deficit reduction commission. Although the panel last week proposed a combination of cost cuts and tax increases, the deal struck this week involves spending increases and tax cuts. Hiking the tax rate on carry would at least have been a gesture towards what’s needed longer term.

Moreover, it’s a question of simple equity. Carried interests earned by buyout firms and a few others substitute for the fees charged by more traditional kinds of investment managers. Pete Peterson, the co-founder of buyout firm Blackstone who cashed out in 2007, conceded as much last week and suggested carry should attract higher taxes than it does currently – even though his former colleague, Schwarzman, likened Obama’s support of the plan to Hitler invading Poland, later apologizing.

With carried interests taxed as they are, part of the ultra-rich population ends up with a proportionately light tax burden. That’s regressive and unfair. However modest the impact on America’s finances, abandoning this particular tax increase, as looks the case for now, sets a disappointing example.

Richard Beales is a columnist for Breakingviews, a news commentary service owned by Thomson Reuters, publisher of peHub Wire. The opinions expressed here are his own. Reach him at richard.beales@thomsonreuters.com.